KUALA LUMPUR: Moody's Investors Service has affirmed the Government of Malaysia's local and foreign currency issuer and senior unsecured bond ratings at A3. The outlook is maintained at stable.
It said late Thursday the key drivers underpinning the A3 rating and stable outlook are:
1. Moody's expectation that the government's debt burden will remain high but broadly stable
2. The relatively high exposure of the economy and financial system to a tightening in external financing, as reflected in low reserve coverage of external payments, although balanced by several mitigating features; and
3. Malaysia's healthy and resilient growth prospects.
Moody's has also affirmed the A3 senior unsecured ratings to the US dollar trust certificates issued by Malaysia Sovereign Sukuk Berhad and Malaysia Sukuk Global Bhd, special purpose vehicles established by the Government of Malaysia.
These trust certificates are considered direct obligations of the Malaysian government and their ratings automatically reflect changes to Malaysia's sovereign rating.
Moody's has also affirmed the instrument ratings on senior unsecured debt issued by Khazanah Nasional Berhad at A3. The Malaysian government guarantees these instruments.
Malaysia's long-term foreign currency (FC) bond ceiling is unchanged at A1 and its long-term FC deposit ceiling is A3. Malaysia's short-term FC bond and deposit ceilings are also unchanged at P-1 and P-2 respectively.
These ceilings act as a cap on ratings that can be assigned to the FC obligations of entities other than the government that are domiciled in the country.
The long-term local currency (LC) bond and deposit country ceilings are unchanged at A1.
First driver: Moody's said government debt burden will remain high but broadly stable.
It said at 50.9% of GDP as of June 2017, Malaysia's general government debt is significantly higher than the A-rated peer median (40.5% of GDP at end-2016).
While it expects the debt ratio to remain stable in the next few years, it is also likely to stay above the median for A-rated sovereigns.
The government's commitment to fiscal consolidation has resulted in fiscal deficits narrowing in each of the past seven consecutive years.
“While the pace of consolidation will slow going forward, we still expect the deficit to narrow slightly further to 2.8% of GDP in 2018 in line with the budget projections, from 3.0% in 2017 and 6.7% in 2010,” it said.
Deficit reduction has been achieved mainly through tighter spending and the introduction of a Goods and Service Tax in 2015. However, absent further meaningful revenue-raising measures, additional fiscal consolidation will be limited.
In Moody's view, achievement of the government's goal of a balanced budget will thus rest primarily on an expansion in growth, rather than any structural budgetary measures.
It does not expect this objective to be achieved by the government's original target of 2020.
Policy space and debt affordability are constrained by a much narrower revenue base than available to other A-rated sovereigns.
“Indeed, according to the government's budgeted estimates, revenues will decline as a proportion of GDP, to 16.6% in 2018 from 16.8% in 2017, a continuation of the trend seen since a recent peak in 2012 (when revenues stood at 21.4% of GDP) which was in part due to exposure to oil price trends.
As a result, debt affordability is weak relative to peers, with interest payments accounting for 12.5% of revenues in 2016, much higher than the A-rated median of 5.6%.
A key mitigating factor is the low proportion of foreign-currency denominated government debt, which reduces vulnerability of the government's debt servicing costs and debt burden to exchange rate depreciations.
At end 2016, only 3.6% of Malaysia's direct government debt was denominated in foreign currency. Moreover, a significant proportion of domestic, local-currency debt is held by large investors with stable demand for government securities such as the Employees
Provident Fund and the civil servant pension fund.
Second driver: High exposure of the economy and financial system to a tightening in the availability and cost of external financing
The active non-resident investor presence in Malaysia's financial markets leaves it vulnerable to sudden swings in capital flows.
Foreign currency reserves have climbed steadily from a recent trough, but remain lower
than economy-wide cross-border debt due over the next year.
Foreign reserves are larger than short-term debt by original maturity. However, once currently maturing medium- and long-term debt is added, the ratio of annual external liabilities due to reserves -- as measured by Moody's external vulnerability indicator (EVI) -- has been significantly above the 100% threshold for many years.
“We forecast it at 139.7% for 2018 and do not expect it to change significantly in the next few years,” it said.
Moody's said there are several mitigating features against these external vulnerabilities.
A sizeable surplus on the net international investment position acts as a cushion.
A large domestic institutional investor base also provides supportive demand, at least for local currency debt, should foreign investors' appetite for Malaysian assets diminish.
Resident banks and corporates hold three-quarters of Malaysia's external assets ($297.6 billion, as at end-3Q 2017). These can be drawn upon to meet their external debt obligations ($155.7 billion as at end-3Q 2017), without creating a claim on official reserves.
The current account is also in surplus position and is expected to remain so, although it has narrowed to 2.8% for the first three quarters of 2017, from a peak of 16.6% of GDP in 2008 and provides less of a cushion than in the past.
Third driver: Healthy and resilient growth prospects
It said Malaysia has a highly diversified and competitive economic structure.
Between 2012-21, we expect GDP growth to average 5.1%, making Malaysia one of the fastest growing A-rated sovereigns, surpassed only by China, Ireland, and on par with Malta.
Growth's resilience through external headwinds, such as the fall in commodity prices and oil prices and a tumultuous political climate, is a testament to the economy's shock absorption capacity.
Material domestic imbalances continue to pose a risk to growth and the financial system.
Household debt has moderated to 84.6% of GDP at the end of September 2017 down from 88.3% of GDP as of end 2016, but is still amongst the highest in the region. Such debt could slow growth in the medium term if it constrains households' capacity and willingness to spend.
It could also amplify the negative effects of a shock to the economy. While household financial assets are over twice as large as household debt, there remain pockets of risk in some segments, particularly the low-income group.
Like several other countries in the region and beyond, Malaysia faces the challenge of meaningfully lifting productivity growth in order to sustain medium-term GDP growth and avoid the middle-income trap.
“However, given the relatively well-diversified nature of the economy and its ability to withstand shocks in the past, we expect that growth performance will continue to be robust relative to similarly-rated peers, which is a key factor underpinning the stability of the debt burden.
Rationale for stable outlook
The stable outlook balances long-standing credit constraints -- a high debt burden and vulnerability to external risks -- against inherent credit strengths, including resilient economic growth and the presence of sizeable domestic institutions providing stable financing conditions for the government's debt.
In the absence of further reform, we expect that the government's demonstrated commitment to fiscal consolidation will only result in limited improvement on Malaysia's public indebtedness and debt affordability.
However, a robust growth path, which provides the base for an expansion in nominal GDP, lends stability to this debt burden.
While a large foreign investor presence and exposure to commodity-related exports leaves the external position vulnerable to broader shifts in interest rates and global commodity price movements, underlying mitigating factors, including Malaysia's deep domestic capital markets and strong external position, cushion the impact of such volatility.
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